Save Article

Big Change in Store for Brokers in Obama's Oversight Overhaul

By

Jane J. Kim and

Aaron Lucchetti

Updated June 19, 2009 11:59 p.m. ET

Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher "fiduciary" standard that would compel them to place their client's interests ahead of their own.

Currently, brokers are only required to offer investments that are "suitable," which means they can't put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated.

"This is a smart and overdue move" for the large brokerage firms owned by investment banks, says Sallie Krawcheck, who formerly ran the wealth-management business at Citigroup Inc. "It's certainly a victory for clients."

Many investors don't even know the difference between the two standards, believing their brokers already are acting in their best interests.

But requiring brokers to operate under a fiduciary standard could force them to offer products that are less costly and more tax-efficient. They will have to disclose any potential conflicts of interest, such as any fees they may get for favoring one product over another. That could mean clients will be offered fewer proprietary products if the broker can find a lower-cost option elsewhere.

For example, a broker couldn't put you in a mutual fund with higher fees -- or one he gets a bigger commission for selling -- if he could get a comparable fund with lower fees elsewhere, says Tamar Frankel, an expert on fiduciary law at Boston University School of Law.

The proposal addresses a long-simmering debate over how brokers and investment advisers, who have traditionally offered more financial-planning advice, are regulated.

For years, investment advisers -- regulated by the Securities and Exchange Commission as part of the Investment Advisers Act of 1940 -- have been held to a fiduciary standard, meaning that in serving the clients, they have to put their clients' interests first. Brokers were excluded from that definition of investment advisers as long as they didn't get paid special compensation for that advice, and gave it as "solely incidental" to their brokerage services.

But over the years, that distinction became more blurred as brokers held themselves out as financial planners, even as they continued to operate under the more lenient standards. Making matters more confusing is the fact that some brokers became dually registered, operating under a suitability standard when they are selling products, but under a fiduciary standard when doling out investment advice.

Richard Ketchum, chairman of the Financial Industry Regulatory Authority, says "a fiduciary standard should be established for broker-dealers when they are offering investment advice." He said the SEC should lead a discussion of how to define those situations and adds that features of both broker and adviser regulation should be kept.

The Intelligent Investor

The change also will give investors more power if they take their broker to court. "If a fiduciary violates his duty -- that is, gives advice which is contaminated by self-interest -- he could be sued not only for damages that have been caused for this advice but could also be sued for punitive damages," says Boston University's Ms. Frankel.

The tougher fiduciary standard would discourage brokers from charging trading commissions instead of fees based on a client's assets, says Alois Pirker, a senior analyst at Aite Group LLC. That is because brokers could be accused of recommending trades simply to drive up their commissions. Some firms have already been encouraging brokers to register as investment advisers.

The Securities Industry and Financial Markets Association, a Wall Street lobbying group, has pushed for updating standards so brokers and financial advisers are held to the same rules when they provide the same service to clients. But the group stops short of saying the standard should be the more expansive and potentially more costly fiduciary standard.

Changing to a tougher standard won't be easy. "They're going to have to rejigger the whole bloody thing...and rethink what services they offer and by whom," said William Spiropoulos, chief executive of CoreStates Capital Advisors LLC, a Newtown, Pa., money manager. Mr. Spiropoulos, who worked as a broker for many years, now operates under the tougher standard.

Big Change in Store for Brokers in Obama's Oversight Overhaul

Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher &quot;fiduciary&quot; standard that would compel them to place their client's interests ahead of their own.